What Will My Portfolio Be Worth in 10 Years?

Every investor wants to know where their money is going.

The point of investing is for your money to grow. Sometimes, you're trying to achieve a specific goal, such as to retire, buy a home, or take a big trip. Other times you just want to put your money somewhere more fruitful than a savings account. This writer alone has been chastised several times by his bankers and advisors for keeping far too much cash on deposit, as there's a very real opportunity cost to that kind of thinking. There’s often also more risk involved.

No matter why you hold any given portfolio, every investor has the same basic questions: What will this be worth? What are my gains and risks? If you hold money in a portfolio for 10 years, for example, what will it be worth?

Here are some ways to approach this question. You can also consult a fiduciary financial advisor if you have questions about your portfolio.

Above All Else, Understand Uncertainty

More than anything else, you must understand this: All investment is uncertain.

This is the catch-22 at the heart of personal finance. For most households, investment is necessary to achieve the big financial goals. To buy a home or build a secure retirement, you will typically need portfolio returns. But a portfolio makes no promises. No matter what assets you buy, losses are always possible.

When it comes to understanding uncertainty, there are two essential elements.

First, risk management must be central to your planning. There are many ways to figure out what your portfolio will be worth in 10 years, but under any model you could always take losses. The questions are how much risk you can accept, how you will mitigate that risk, and how you will manage potential losses.

Second, you must understand your assumptions. Whether you are building an investment strategy or projecting your portfolio value, what are you accepting as necessary and true? For example, do you assume that your bonds won't default? Do you assume the S&P 500 will maintain historic growth rates? Or that you will maintain your current rate of income?

Understand that all investment has risks and any strategy involves assumptions. This is essential to investment. A financial advisor can help you build a risk-appropriate investment strategy.

Portfolio Benchmarks And Indices

When trying to project portfolio value over several years, typically you will use two methods: promised growth and average growth. Note that "promised" return and "guaranteed" return are not the same thing. There is no such thing as a guaranteed return.

Promised growth is typically associated with contract or debt assets like Treasury bonds, corporate bonds and annuities. Here, a third party has promised you a rate of payment, typically in exchange for a loan (in the case of bonds) or an up-front investment (with annuities). You can then project out your portfolio growth on the assumption that they will not default on this promise.

For example, say that you hold a $100,000 portfolio of bonds with an average 5% interest rate. Assuming these bonds make their payments on time and in full, in 10 years that portfolio might be worth about $ 162,889 if you reinvested dividends.

Average growth is the historic rates of return for your investments. This is typically associated with market-based investments like stocks, derivatives and real estate. Nobody has made you any promises. Instead you will project growth based on how similar assets have performed in the past, on the assumption that those markets will post broadly similar results in the future.

Typically, investors will use standard benchmarks to try and project average growth. For example, the S&P 500 has an average annual rate of return around 10.5%. If you invest your money in an S&P 500 index fund, you might project similar results. Or, say your portfolio holds 60% stocks/40% bonds. Historically those portfolios have grown by 8.6% per year on average. A more conservative 40% stocks/60% bonds portfolio, on the other hand, will have historic average growth of 7.6%.

These benchmarks can give you a place to start when you are projecting out future growth. For example, say you hold $100,000 in a 60% stock/40% bonds portfolio. In 10 years at that 8.6% rate, it might be worth about $ 228,191 .

Just remember that benchmarks are educated assumptions. They can tell you how similar portfolios have performed in the past, but that's no guarantee those rates will continue. And benchmarks are simple averages, meaning that in most years similar portfolios will significantly out- or under-perform the average. The longer out you forecast growth, the more likely it is that your portfolio will trend toward the averages. If you're just trying to predict portfolio growth over the next few years, though, a benchmark may be more misleading than helpful.

A financial advisor can help you make calculations to project various scenarios. Get matched with a fiduciary advisor.

Adjust Value For Inflation and Taxes

Two major factors will drag down your portfolio's value over the long run: inflation and taxes.

Inflation measures the general rise in prices across an economy. It erodes the spending power, and effective value, of money. The Federal Reserve targets an average annual inflation rate of around 2%, although that's a national average. Expensive areas and certain sectors will often see faster rates of inflation.

Anticipate this. Each year's rate of inflation will offset your portfolio's growth by an equivalent amount. For back-of-envelope purposes, you can assume a one-to-one ratio. For example, say that your portfolio grew by 8% last year and the CPI grew by 2.5%. You can roughly say that your portfolio's spending power grew by 5.5% (8 – 2.5).

For more accurate projections, you can use the formula for inflation-adjusted returns:

• Inflation Adjusted Returns = (1 + Returns) / (1 + Inflation) – 1

To take our example above, your portfolio's value would grow by:

• (1 + 0.08) / (1 + 0.025) – 1
• 1.08 / 1.025 – 1
• 1.053 – 1 = 0.053

Your more precise inflation-adjusted growth estimate is 5.3%.

In addition to inflation, the other major drag on your portfolio's long-term value will be taxes. A typical investment portfolio might have some combination of three tax statuses:

• Income Tax
• Capital Gains Tax
• Untaxed

Income taxes will apply to pre-tax retirement accounts, short-term (less than 12 months) investments and some yields like dividend payments. For investments subject to the income tax, prepare to reduce your actual value by your average income tax rate.

Capital gains taxes will apply to long-term capital assets held outside of a tax-advantaged retirement account. For example, if you sell stocks or real estate held for longer than 12 months you will pay capital gains taxes on your profits.

Finally, post-tax retirement accounts do not trigger any taxes when you take a withdrawal. This applies to Roth IRA and Roth 401(k) portfolios. In both cases, your withdrawals are not taxed and do not apply to your taxable income for any other purposes. Remember, a financial advisor give you professional advice if you have more questions.

The Bottom Line

Predicting how much your portfolio will be worth over time is important. It can help you plan for major life events and purchases, and lets you understand how much you should invest to meet your goals. However, it's critical to understand the risks, assumptions and drags associated with long-term growth.

Tips On Planning for Portfolio Growth

• Predicting your portfolio is one step in this process. The other step is building an investment plan. Whatever your goals are, once you have a sense of your portfolio's risks and potential, next it's time to start planning for how you will save in order to take advantage of that growth.
• A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now .
• Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks .

Photo credit: ©iStock.com/Kobus Louw

The post What Will My Portfolio Be Worth in 10 Years? appeared first on SmartReads by SmartAsset .